Chemical Engineering

Predictions that the 1991 merger of New York’s Chemical Bank and Manufacturers Hanover would underwhelm proved shortsighted. Chemical CEO Walter Shipley is fine tuning a model his peers might like to replicate.

Can a diversified, global, money-center bank consistently turn a profit? Can the merger of two large underperforming banks succeed? Until a few years ago, some experts held that the answer to both these questions was an unequivocal “no.”

There was ample reason for skepticism: Having watched big banks bumble their way through successive crises in energy loans, Third-World debt, and real estate loans in recent years-and standing by while several ran aground at taxpayers’ expense-industry observers advised downsizing and a determined refocusing on core businesses.

Then Manufacturers Hanover’s John McGillicuddy and Chemical’s Walter Shipley bumped into one another in 1991, likely on Park Avenue, the fashionable New York promenade where both banks had their headquarters. In a summer of love for the industry that included megamergers between California‘s Bank of America and Security Pacific, and southeastern giants NCNB and C&S/Sovran, the two executives courted briefly, then decided to deal. Silencing rumors about possible combinations with Chase Manhattan and Bank of New York, Shipley and McGillicuddy announced a $2.27 billion stock swap between their companies in July. It would be Chemical and Manufacturers Hanover for better or worse.

Suffice it to say, the nuptial has been an unqualified success. It created a bank with $140 billion in assets, at the time, the second largest in the U.S. behind Citibank. (The new Bank of America now ranks second, and Chemical third.) In fact, the new bank’s performance has outstripped even the lofty expectations of Shipley and McGillicuddy.

Shipley says the merger aimed to extract excess capacity and to cut costs. At last count, it had eliminated 6,200 of 45,000 employees, 80 of 660 branches, and one of two headquarters buildings. Total savings on an annualized basis of $525 million since the merger are projected to increase to $725 million by 1995.

What wasn’t fully foreseen, he frankly admits, is the competitive advantage that would accrue to the new Chemical. In most banking markets and businesses, he explains, even leaders usually have only a small share. Thus, the combination of runners-up can create a new No. 1 in a category. Market leadership, in turn, means a bigger bottom line. Cost savings and higher profits helped Chemical to raise some $1.5 billion in equity, which it used to recapitalize and sharpen its competitive edge in a variety of businesses, says Paul Mackey, senior banking analyst at Dean Witter in New York.

For example, $149.9 billion-asset Chemical now comfortably dominates the market for global loan syndications. The bank has achieved similar, though less dramatic, successes in consumer and middle-market lending, and in fee-based businesses, such as derivatives trading and transaction processing. According to a recent survey by Goldman Sachs, Chemical has replaced Morgan Guaranty as the bank with the most primary relationships to U.S. Fortune 1000 companies. Net income for 1993 jumped 48 percent to $1.6 billion. Return on equity was a solid 16.66 percent, compared with 12.36 percent in the year-earlier period.

If Chemical has drafted a new blueprint for merger success, why haven’t more banks followed it? The answer lies partly in Shipley’s self-effacing modesty, and in his willingness to step aside while McGillicuddy initially took the reins. Shipley insists both he and McGillicuddy put their egos on the back burner while working out details of the deal, including which top lieutenants would stay and which would go. “It was truly a merger of equals,” he says. “No one was the aggressor; no one had to merge to save his bank.”

Analysts generally give the bank high marks, though some feel Chemical may be spreading itself thin in focusing on corporate, retail, and investment banking. “Chemical is trying to decide what it wants to be when it grows up,” says one longtime observer of the bank. Dean Witter’s Mackey disagrees. “Other banks got into trouble moving into unfamiliar markets and businesses,” he says. “Chemical capitalizes on its strengths and focuses on markets it knows.” Mackey gives the company’s stock an “accumulate” rating, second-highest on a five pointscale.

Quick to laugh and easygoing to a fault, Shipley responded to a tongue-in-cheek question about whether photos of his 6foot-8-inch frame would fit onto the pages of CE. “You might need a wide-angle lens,” he quipped. In a discussion with CE managing editor Joseph L. McCarthy, the once and present Chemical CEO touched on a range of topics, including challenges for the company, competition from non-banks, and the prospects for nationwide banking reform.

BIG BANG

Many skeptics said the merger of two less-than-stellar-performing banks couldn’t possibly work. What convinced you it would?

It’s important to distinguish between what we knew going in and what became clear only in hindsight.

Beforehand, we were thinking primarily about cost reduction. We are in an industry that has extreme excess capacity. We knew that with an in-market merger, we would take out some of this capacity. This makes the Chemical-Manufacturers Hanover merger similar in some respects to the Bank of America-Security Pacific combination, but unlike the majority of NationsBank or Banc One consolidations.

It was more difficult for us to gauge the enhanced market positions that would result from the merger. In the wholesale side of business, for example, we thought one and one would add up to less than two. We thought there would be overlap. The result has been the opposite. In foreign exchange, too, synergies were created. Chemical was primarily a market maker. Manufacturers Hanover had much stronger client contacts.

In the area of global loan syndications, where we’ve achieved perhaps our most visible success, we last year originated, structured, and distributed some $185 billion in bank credit facilities, up from $110 billion in 1992. In this area, again, the old Chemical had focused heavily on the distribution of paper, while Manufacturers had a stronger client base.

Chemical seems a throwback to institutions that thought they could be successful engaging in almost every type of banking activity. Many people have tried that; nearly as many have gotten into trouble.

Chemical and the old Manufacturers Hanover were too broad-based for their respective levels of capital, and for the market share positions they didn’t have. Bigger is not always better. We believe, however, that if you have the necessary capital, market share, and talent, then diversity-engaging in a variety of businesses-becomes a strength, not a weakness.

For one thing, you get income sources that complement each other through business cycles. That means balance and consistency of earnings. Here’s an example: The consumer deposit business today is lousy. We don’t make any money when interest rates are 3 percent. But these same low rates are very attractive if you’re in the credit card business.

If you’re spread too thin, and if your competitive position is weak, you become vulnerable to the market leaders. If you have strong market positions and invest wisely in your businesses, diversity becomes a strength.

But diversity doesn’t mean being all things to all people, does it?

No, no, no. Our mission statement says that our mission is to be the best broad-based financial institution, a leader in our chosen markets. So we put all of our businesses up against this test: Are we in a leadership position or can we achieve that in a reasonable period of time-along with appropriate returns on our investments?

Leadership usually means being first or second in a given area, but not always. It depends on the business. In consumer banking at the branch level, you have to be one, two, or maybe three. If you’re not, you face a pretty tough battle. In something like national credit cards, you have full competitive scale if you’re in the top 10, though it’s best if you’re in the top six or seven.

What sorts of businesses aren’t measuring up to the “leadership” test?

We recently sold 30-odd consumer branches in upstate New York to Fleet. Thirty branches do not constitute a leadership position. We also sold some operations in Texas, where we were the fourth or fifth competitor.

COURT AND SPARK

As the merger progressed, how did you and John McGillicuddy decide whom to cut and whom to keep?

We sat in a room and asked ourselves who our top dozen people would be. This helped us to build a relationship. In terms of making cuts, it’s easiest to describe the process in football terms. The Giants are an excellent team, and the Jets have a lot of talent, but if you let me merge the two teams together, I bet I can produce a Super Bowl winner. The new Chemical truly has a depth of talent.

Your logic is compelling. But if it’s so easy, why haven’t there been more in€.market mergers of equals?

There was a personal affinity between John McGillicuddy and Walter Shipley. At the time we began talking, we had known each other for 30 years, we both had been chief executives for some time, and we were able to bypass our egos.

Here’s another analogy. Take two single parents who lost their spouses through death or divorce. They fall in love, get married, have children, and bring the children together into a new family. There is jealousy: The kids worry about whether dad or mom will pay as much attention to them as he or she did before. The kids also are watching to see whether the two parents will get along.

That’s what happened when John and I brought the banks together. We knew the whole thing rested on our relationship together. We felt comfortable with that.

Meanwhile, let’s take this analogy a step further to reflect what’s going on in the wake of John’s retirement. Let’s say this imaginary couple was married for two years, and the combination of their families worked wonderfully. Then one parent dies. I’m now in the position of the parent who is left behind. I’m the surviving single parent, and our employees are all my children.

Sounds like a soap opera.

[Burst of laughter.] I know, but that’s what’s happened here.

Were there any problems combining the cultures of the two companies? Some analysts noted at the time that the Chemical kids were coming in to the new family with suspenders, while the Manny-Nanny kids were coming in with blue jeans.

Both sides have street fighters, and both sides have aristocrats. Besides, the new company is in such a different competitive position that all of us had to adopt quickly to a new culture. The “us and them” phase was surprisingly short.

Here’s one way your family analogy doesn’t apply: In the new Chemical, there obviously wasn’t room for all of the kids. How did you deal with downsizing?

We made our decisions quickly to minimize the pain both for those who were to go and those who were to stay. We put in an early retirement option that turned out to be more costly than we anticipated, but it helped, because among those who remained with the bank, you didn’t hear anyone say: “Gee, they really screwed that guy.”

All told, the downsizing amounted to 6,200 employees. Some 2,000 employees were laid off, 2,000 took early retirement, and 2,000 came from attrition. It’s important to deal with this situation in the right way. For us, that meant taking talent from both organizations. I started with the New York Trust Company. In 1959, the old Chemical Bank bought us. Within a couple of years, all the top management of New York Trust was gone. That generated a lot of negative emotion

PUSHING THE ENVELOPE

Do you expect any significant banking reform during the rest of Bill Clinton’s term?

He’s proposed reform of the regulatory process. That’s on the table at the moment, though not yet in the form of a bill.

Some changes in Glass-Steagall and interstate banking are being made through the reinterpretation of existing statutes. We expect that process to continue. For example, the Federal Reserve has given Chemical and other well-capitalized banks the authority to underwrite equity and corporate bonds. And recently, the Comptroller of the Currency allowed First Fidelity in New Jersey to merge its Pennsylvania and New Jersey banks. The standing interpretation said any bank can move its headquarters 30 miles. In the case of New York and New Jersey, 30 miles happens to cross a state line. So in the case of First Fidelity, the merger stretches the interpretation.

You’ve been active in international banking at a time when many other American banks have scaled back. Why?

The merger left us in a very good position, but there’s another point to cover here. Over the last 10 years, we’ve had a shakeout, so all of a sudden, the international business has become attractive again.

Every multinational company in the world wants to have a relationship with a large American bank. Mercedes may have its principal German bank, but it also has important relationships with selected, multinational banks outside the country.

To what extent do you think non-banks will continue to eat into the market share of traditional banks?

What is “banking” will continue to get blurred. Technology is a huge issue for service businesses, and banking is a service. New delivery systems will allow non-traditional competitors to come in and take a hunk. If you don’t believe that, look at the success of the AT&T credit card.

Perhaps the toughest strategic issue for banks will be managing these systems and the evolution of consumer banking from the traditional, branch-delivery mentality to using new methods and selling new products, such as mutual funds.

Do you ever wonder where Chemical would have been if it had stayed on its own, or if it had paired with another institution?

I think we did something unusual and unique. I would love to be able to do it again some time, but it’s difficult to achieve a true merger of equals.

And no, I don’t think it could have been better with anybody else. We’ve never looked back .